Sunday, January 11, 2015

The failure of the financial institutions are not by accident

I will oversimplify here, but basically it categorized some assets as
"safe" and some as "risky". Those that were risky had their value cut
in half for purposes of capital calculations, while those that were
"safe" had their value counted at 100%. So if a bank invested a million
dollars in safe assets, that would count as a million dollar towards
its capital requirements, but would count only $500,000 towards those
requirements if it were invested in risky assets. As a result, a bank
that needed a billion dollars in capital would need a billion of safe
assets or two billion of risky assets.

...

Anyway, what assets did the regulators choose as "safe"? Again, we
will simplify, but basically sovereign debt and mortgages (including the
least risky tranches of mortgage-backed debt). ...

And for most banks, this was mortgage-backed securities. So, using
the word Brad DeLong applied to deregulation, there was an "orgy" of
buying of mortgage-backed securities. There was simply enormous demand.
You hear stories about fraud and people cooking up all kinds of crazy
mortgage products and trying to shove as many people as possible into
mortgages, and here is one reason -- banks needed these things.

So with this experience in hand, banks moved out of mortage-backed
securities and into the last "safe" asset, sovereign debt. And again,
bank presidents told their folks to get the best possible yield in
"safe" assets. So banks loaded up on sovereign debt, in particular
increasing the demand for higher-yield debt from places like, say,
Greece. Which helps to explain why the market still keeps buying up
PIIGS debt when any rational person would consider these countries close
to default. So these countries continue their deficit spending without
any market check, because financial institutions keep buying this stuff
because it is all they can buy.

When Greece (and Portugal, and Spain, and Italy) leaves the Euro and defaults - as it certainly will, sooner or later - it will be the sub-prime mortgage crisis all over again but ten times bigger.

Notice of Cookies

Cookies in use. If you're in the EU, consider this a warning. The is a Blogspot site, so Google runs the backend. I don't know what they are doing with the cookies and they're not saying. If you are concerned that Google is tracking you, you should never visit a Google Blogspot site, use Gmail, or use Google as a search engine.

If you are concerned about being tracked on the internet, you should log off, shut down your PC, move to a cabin in the woods, grow your own food, never visit a bank, use a cell phone, or drive a car made after 1999. Don't go outside and look up at the sky, either.

If you are visiting this site from a EU country, you should get an annoying popup at the top of the screen. If you want to see it, here it is in English: http://www.borepatch.blogspot.co.uk/